Safe or sorry?
By John Schooler
We may be experiencing the worst United States financial crisis in a generation. Last week, our country’s GSEs (Government-Sponsored Entities) Fannie Mae and Freddie Mac needed government assurances that it will stand behind them in order to calm investor’s fears.
A bill just passed in the House of Representatives giving Treasury Secretary Henry Paulson power to inject capital into Fannie Mae and Freddie Mac. The seizure of California-based IndyMac Bank by federal regulators increased the worries that the troubles could spread to commercial banks and ordinary depositors. So what would happen to regular banks?
Are depositors safe from a possible meltdown of the financial institutions? How can regular depositors protect themselves when their assets are in a savings account, money market account or a regular CD? And what about other financial institutions like securities firms? How should we process all this information and what actions can we take?
The first response to these questions is that deposits in commercial banks are considered safe since they are insured by a federal insurance if the bank fails. The FDIC as it is called, stands for the Federal Deposit Insurance Corporation and it preserves and promotes public confidence in the U.S. financial system by insuring deposits in banks for at least $100,000. As an independent agency of the federal government, the FDIC was created in 1933 in response to the thousands of bank failures that occurred in the 1920s and early 1930s. Since the beginning of FDIC on January 1, 1934, no depositor has lost a single penny of “insured” funds as a result of a bank failure.
Savings, checking and other deposit accounts such as CDs and money market accounts are generally insured to $100,000 per depositor in each bank the FDIC insures. A money market account is a savings account that offers the competitive rate of interest in exchange for larger than normal deposits. These accounts are also known by the acronym MMDA, which stands for money market demand account or money market deposit account. Many money market accounts place restrictions on the amount of transactions you can make in a month such as five or less. Furthermore, you usually have to maintain a certain balance in the account to receive the higher rate of interest. Some banks require at least $500; others require a much higher balance.
Deposits held in different categories of ownership and without the protection of a trust, such as single or joint accounts, may be separately insured. Depositors, without a trust, can mitigate risk if they have more than $100,000, by having different account holders on the title, as each of this would be separately insured. Lets take an example: If a husband and wife have $300,000 in a bank they could title the accounts as: John Doe and deposit $100,000. Jane Doe and deposit $100,000, John Doe and Jane Doe JTWROS and deposit the remainder $100,000. Depositors with a large amount of money under a trust can stay protected by diversifying their deposits among different bank institutions instead of taking some of their money out of the trust.
Also, the FDIC generally provides separate coverage for retirement accounts, such as individual retirement accounts (IRAs) and Keoghs, insured up to $250,000. The FDIC insures cash deposits only. It does not insure securities, mutual funds or similar types of investments that commercial banks may offer.
Another way to protect large amounts of money deposited into a commercial bank is to sign up for CDARS. CDARS is the Certificate of Deposit Account Registry Service, and your bank will have to be part of the network. When you place a large deposit with a network member, usually more than $100,000, that institution uses CDARS to place your funds into certificates of deposit issued by other banks in the network. Going back to the previous example, John and Jane Doe have $300,000 to deposit into a CDARS network bank. The bank will take those $300,000 and split them into four CDs offered by other network banks and deposit $75,000 in a CD offered by bank “A,” $75,000 in a CD offered by bank “B,” $75,000 in a CD offered by bank “C,” and the last $75,000 in a CD with bank D. The deposits need to be in increments of less than $100,000 to ensure that both principal and interest are eligible for full FDIC insurance. The full amount of your original deposit becomes eligible for complete FDIC protection and you will receive just one regular statement detailing all your holdings. By using the CDARS service, you can access up to $50 million in FDIC protection for your CD investments.
So what about assets held at securities firms and other institutions not covered by FDIC? Securities firms and more sophisticated investment institutions have their own insurance called SIPC. The Securities Investor Protection Corporation acts as trustee or works with an independent court appointed trustee in a missing asset case to recover the funds. The statute that created SIPC provides that customers of a failed brokerage firm receive all nonnegotiable securities that are already registered in their names or in the process of being registered. Funds from the SIPC reserve are available to satisfy the remaining claims of each customer up to a maximum of $500,000. This figure includes a maximum of $100,000 on claims for cash.
Most brokerage firms, including Southwest Securities Group which is our clearing firm, will buy additional insurance to protect clients assets in the event of the firm’s failure. A clearing firm is an organization associated with a securities firm to handle the confirmation, settlement, and delivery of all transactions. Individual customer accounts at all of the SWS Group and securities firm’s subsidiaries are afforded unlimited protection, with an aggregate limit of $100 million. Southwest Securities purchases an Excess Securities Bond from a major insurance company to supplement this basic coverage.
Customer assets in the possession of SWS Group and its securities firms are protected under SIPC and the supplemental protection. This coverage does not protect against fluctuations in the market value of securities, including loss of principal on an investment or cash.
Money market mutual funds, which may also be available as customer select sweep options on their broker accounts, are treated as securities and are registered with the Securities and Exchange Commission (SEC), pursuant to the Investment Company Act of 1940. The Securities Investor Protection Corporation (SIPC) covers most customers of failed brokerage firms including the assets in these money market funds.
A financial crisis is nothing new to our society. Whenever a bubble bursts, there is pain to be felt by someone. The fallout from the housing crisis in America has financially injured many Americans. However, my belief is that our financial institutions are strong and will endure. It is evident by the action of our government that they take this very seriously and that they are going to stand ready to help support the institutions as a whole. Some banks will fail but your deposits at banks and securities firms are for the most part safe, however prudent management of your finances is essential. It is yours and your financial advisors responsibility to help manage that. If anybody has a question about this topic or any other topic related to your personal finances, please give me a call. I am happy to answer questions.
John Schooler is president of WFP Securities. For more information go to
or call (858) 677-0377.